The increasing popularity of decentralized finance—or DeFi— has been widely touted as the death knell for traditional finance, or TradFi. While we're not quite there yet, there is a good reason why DeFi has captured the popular imagination: the total value locked in DeFi protocols has surpassed $100B.
That’s not all. Ethereum, which accounts for over 68% of collateral in DeFi, settled $6 trillion worth of transactions in the twelve months to October 2021.
The market value of Ethereum-based DeFi transactions is proof enough that it is giving TradFi a run for its money. In addition, DeFi may soon be the preferred choice for institutions to fulfill their credit needs due to its ability to provide financing at more competitive rates when compared with TradFi.
Let’s look at how DeFi makes cheaper financing possible.
Financial incumbents in the TradFi space have a high cost of servicing clients, right from onboarding, and trade execution, to post-trade activities such as clearing and settlement. TradFi institutions spend about $20B in trade processing annually, according to an estimate by The Bank of England. TradFi can save up to 80% of post-trade settlement expenses by leveraging distributed-ledger technology (DLT).
The high cost of servicing clients and legacy infrastructure means that TradFi has limited financial innovation ability. Many banks and central securities depositories are piloting tokenization projects that look to improve existing asset classes. These projects, while showing evidence of technical feasibility, fail to go live.
The business case for these projects is a tough one to make when accounting for the cost of migrating to a new system.To add to this, there is the challenge of adjusting existing processes, and stakeholder and user behaviour, in line with any new technology. We saw similar behaviour when sales and trading desks moved from voice to digital. New business divisions with differently skilled personnel grew the digital business, while the personnel and systems dedicated to voice declined.
DeFi is well placed to disrupt TradFi with new, and innovative financing options as it does not use any of the TradFi structures to build its alternative financing structures. “It took Tesla to reimagine a better user experience. Ford or Toyota could not have done this without disrupting existing sales models,” says Elizabeth Matthew, Executive Director at Consensys.The lack of existing market infrastructure solutions within DeFi provide a fertile ground to rethink the user experience in the capital markets lifecycle. This helps create new financial primitives, alternate financing structures and yield generating opportunities. DeFi now consists of over 17,000 protocols such as Aave, Compound and Uniswap for lending, borrowing, staking, hedging, swapping and yield farming.
DeFi has also dramatically shrunk the cost of manufacturing and distributing various assets, similar to what the internet did for publishing and advertising. One reason for these lower costs is DeFi’s peer-to-peer lending mechanism that strips out the third-party intermediary. This means that an institution looking to access credit can do so without having to pay a fee to a bank or another financial institution to grant that access.
MetaMask Institutional (MMI), the institution-compliant version of the most used and trusted DeFi wallet MetaMask, provides access to DeFi’s unbound innovation with the widest access across EVM-compatible protocols. This is because almost all dapps are built to integrate with MetaMask. Through MMI, organizations can implement investment strategies for trading, lending, yield farming, and more.
Only MMI provides unrivaled access to DeFi without compromising on institution-required security, operational efficiency, or compliance requirements.
This post is the first of a three-part series on why DeFi is the future of finance. Our next posts will focus on how DeFi will make it easier for organizations to share know-your-customer (KYC) information, and how the concentration of capital among a few TradFi institutions is a boon for DeFi.